Understanding Inflation in a Full Employment Scenario: Factors and Implications

In the context of economics, the relationship between full employment and inflation is not always straightforward. This article explores the nuances of how inflation can set in even when the economy is at full employment, providing insights into demand pull inflation and other factors that contribute to price increases.

Introduction

Full employment does not equate to zero inflation. In fact, full employment can often lead to a phenomenon known as post-full-employment inflation. This occurs due to a mismatch between supply and demand in the short term, particularly when supply cannot be increased to match rising demand. This article delves into these complexities and examines how different factors can contribute to inflation in such a scenario.

Finding the Right Indicator: Employment vs. Inflation

It's important to distinguish between employment levels and inflationary pressures. Inflation is not primarily driven by employment levels but rather by the balance of supply and demand in the economy. The classic example of the silver standard illustrates how the value of a currency can change over time, not necessarily due to inflation but rather through devaluation.

For instance, the silver standard allowed the exchange of a silver certificate for one ounce of silver. Today, silver sells for approximately $25.95 per ounce, making the modern dollar worth only about 4 cents in terms of the silver standard. This is a result of devaluation rather than inflation. Similarly, when President Johnson removed the U.S. from the gold standard in 1933, the value of the dollar declined, not because of inflation but due to changes in the monetary system.

Cost-Push Inflation

When the economy approaches full employment, wage pressures often escalate as demand for labor exceeds supply. Rising wages lead to increased production costs, which businesses then pass on to consumers in the form of higher prices. This is known as cost-push inflation. It occurs because the rise in input costs cannot be offset by an equivalent increase in supply, leading to higher prices for goods and services.

The Role of Market Dynamics

Market dynamics play a crucial role in determining inflationary pressures. For example, speculation in commodities like food and oil, price fixing, and monopolistic practices can all contribute to inflation. OPEC's ability to control oil prices through production cuts, housing shortages in capitalist markets, and even government subsidies for low-wage workers can all create imbalances that push prices upward.

Fiat Currency and Inflation

In a fiat currency market, inflation can also arise from an excessive supply of money. When there's too much currency available, this not only increases demand but also diminishes the value of money. This effect can be starkly illustrated by the scenario of a person walking down a dirt road who is starving and has no money to buy food. If that person finds a crumpled dollar bill on the side of the road, that dollar becomes incredibly valuable to them because it can save their life. However, if that person is carrying a wagon full of dollar bills, the same crumpled dollar on the ground is less valuable because there are too many dollars available. This extreme example helps to understand the inflationary effect of a large money supply in an economy.

Conclusion

Inflation in a full employment scenario can arise from various sources, including demand pull inflation, cost-push inflation, and the imbalance between supply and demand. Understanding these factors is essential for policymakers and economists to develop effective strategies to manage and mitigate inflationary pressures.

For further exploration of these topics, readers can refer to the articles and studies that delve deeper into the relationships between employment, inflation, and market dynamics.